Solar 201

A few weeks ago, I gave an introductory overview of the solar industry, including a history of solar power, the relevant macroeconomic factors, and a look at the major players. In this follow-up article, we'll take a closer a look at the feed-in tariff policy used to encourage the industry; the simmering trade wars between the U.S. and China; and finally, which, if any, of the PV (photovoltaic) producers would make good investments.

Feed-in tariffsThe most common vehicle government uses to support renewable energy, the Feed-in Tariff (FiT) is often referred to as a subsidy, but really it's a price floor since there is no direct payment from the government.

The process works as follows: Regulators set a price that utilities must pay to renewable energy producers, which can be any entity, from a single-family home to commercial solar power plants, that sells renewably made power to the grid. The price differs depending on the initial cost of the investment, which will be higher for some forms of renewable energy than others, but will be priced so that energy producers can make a reasonable return on their investments. Furthermore, the guaranteed payments from the utilities provide banks with an incentive to lend money to homeowners who install the solar panels. The renewable premiums the utilities pay are then passed on to end users, who generally pay an additional charge of 6% or less. Finally, regulators make price adjustments in order to ensure that the system works to benefit all parties.

The FiT system was invented in Germany in 1991, and since then the Germans have only solidified their status as renewable-energy pioneers. The country holds at least 44% of the world's PV capacity, so it's no surprise that German solar policy holds so much sway over solar stocks.

After a December that saw a total installation of three Gigawatts of capacity, a huge number that matched Germany's expected additions for the whole year, the country's officials indicated that they were planning on reducing the tariff rates, finally doing so on Feb. 23. Solar stocks dove on the rumors, as shown in the chart below.

Source: YCharts.

The government made cuts of 20% to 29% percent on all projects below 10 Megawatts (projects above 10MW had not been privy to tariffs) and promised to continue cutting rates by 0.15 Eurocents/kWh each month. Planned yearly installations will be 2.5 GW to 3.5 GW from 2014-2017 and 900 MW to 1.9 GW after 2017, compared to the whopping 7.5 additional GW installed in 2011. The slowing pace means manufacturers will have to find new customers to make up for the lost German business. Since PV panels are a durable product, the industry relies on new installations for revenue.

China's dominanceWhile Germany has become the clear leader in solar power consumption, Chinese companies have come to dominate the manufacturing side of the industry, thanks in part to more than $30 billion in subsidies from its government.

Many in the industry have accused China of dumping -- the practice of selling a product below fair value in foreign markets to put domestic competition out of business. The U.S. International Trade Commission recently took a step toward agreeing with that claim, issuing a preliminary conclusion in December that American manufacturers have been harmed by the low-price imports. China responded with a promise of its own retaliatory investigation.

While manufacturers support the lawsuit, solar panel distributors and installers have voiced their opposition, explaining that low PV prices help their business and increase the spread of solar power by making it affordable. Joshua Pearce, an electrical engineering professor at Michigan Tech, recently published a report showing that in many regions, solar PVs are actually as cheap as or cheaper than electricity from traditional sources. Furthermore, a much larger percentage of solar jobs come from installation rather than manufacturing: 52% vs. 14%.

Foolish takeawayWith Germany's PV expansion slowing and the U.S. and China potentially entering a trade war, the future of solar is anyone's guess. While the industry likely has a bright future, I can't say the same for all the companies pushing panels today. Solar manufacturers got crushed in the last year as prices and subsidies dropped. Many major producers like First Solar (NAS: FSLR) , Trina Solar (NYS: TSL) , and Yingli Green Energy (NYS: YGE) have lost between 65% and 80% of their value from a year ago. The volatility comes with the territory in a young industry that depends on government's good graces.

Right now, a bet on solar looks worthy only to the more risk-seeking investors. With that in mind, I like the Chinese producers because of their government support and I would look for a company with a strong balance sheet to weather the likely industry contraction as prices continue to drop.

Some other potential plays include the Guggenheim Solar ETF, which provides a basket of companies to invest in, making it safer than investment in any single company would be. Another option is investing in a silicon producer like Globe Specialty Metals (NAS: GSM) or MEMC Electronic Materials (NYS: WFR) , who make the raw material used for solar panels. Considering the PV makers are not very differentiated and silicon-refining capacity is expensive to add, investing in a manufacturer like Globe could provide the safety of a currently only slightly diversified metal supplier, but one with significant exposure to the solar industry should a production boom happens.

However you decide to play the solar market, there's one company in another growing energy industry I suggest you take a look at. Its stock is up more than 60% in the last three months, and it seems like every week it's signing a new deal, so there's plenty more room to run. Find out more about this hot company in the Fool's special free report, "One Stock To Own for the Coming Energy Revolution." You can get it right now. All you have to do is click right here.